Some Public Transit Agencies Made Risky Financial Deals

March 10, 2009 at 6:16 PM EDT

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Some public transport agencies engaged in a similar kind of financial risk-taking that has caused large banks and companies to fail and contributed to the global financial meltdown. Rick Karr reports in the latest installment of the "Blueprint America" series.

GWEN IFILL: Next, how the financial crisis is hitting public transportation.

As we just heard, Fed Chairman Ben Bernanke today singled out insurance giant AIG as one of many companies that took big risks with devastating consequences. It turns out that public transportation agencies also made deals with companies like AIG, and those are now coming home to roost.

We have a report on this from special correspondent Rick Karr. It’s part of our series on infrastructure called “Blueprint America,” produced in collaboration with WNET-New York.

RICK KARR: Public transit systems across the country are facing a crisis: mounting budget deficits. More than 60 transit agencies have proposed fare hikes, service cuts, or both. And they’ve been begging lawmakers for more subsidies.

But there’s another looming fiscal crisis in public transit that could make things even worse: a series of complex financial deals that transit authorities nationwide made with banks in order to stretch their budgets. Now those deals could end up costing systems nationwide billions of dollars.

CAROL KISSAL, Washington Metropolitan Area Transit Authority: I would have to pay $330 million of liquidated damages, which would wipe out my capital budget. So this would mean, you know, no maintenance on track, delay, cuts in service. Repairs would go to the wayside.

Selling transit cars to banks

RICK KARR: The deals are known as sale-leaseback agreements, and they're really tax shelters. When a transit agency spends $4 million to buy a new subway car, it can't do what a for-profit business would, which is, as the car ages, write wear-and-tear off its taxes, because it doesn't pay any taxes.

But a bank can write off that wear-and-tear. So, according to Samuel Staley, who advocates market-based transit solutions at the Reason Foundation, the idea was for the transit agency to sell the car to the bank.

SAMUEL STALEY, transit economist, Reason Foundation: I can depreciate the value, because these trains wear out. So if you can use that depreciation to reduce your tax liability, it actually can work out to be a pretty decent deal.

RICK KARR: The bank got its tax break while the transit agency got a windfall of about $250,000 from the sale that it could, for example, use to pay for maintenance. The agency would deposit the right of what it got from the sale into an interest-bearing account, then use that interest to lease the car back from the bank, a classic win-win, at least on paper.

Sale-leaseback seemed like such good deals that dozens of agencies got involved: Washington, New York City, New Jersey, St. Louis, Houston, Los Angeles and 25 others. They sold banks billions of dollars' worth of equipment and facilities in an effort to stretch tight transit budgets.

CAROL KISSAL: Most of these transit entities have a very limited amount of capital investment to use for repairs for their buses, to buy rolling stock, rail cars, to make infrastructure improvements. And as a result, these were ways to actually capture some capital to make those investments.

RICK KARR: Banks and transit agencies weren't the only parties to the sale-leaseback deals. They also involved insurance giants, including AIG.

SAMUEL STALEY: The banks weren't going to enter into these lease agreements with the transit agencies unless they had some assurance that, if something would happen in the contract, that they would be covered financially. So the insurance agency -- in this case, AIG -- they said, OK, we're going to be there to get you back if for some reason a transit agency defaults.

Transit agencies break contracts

RICK KARR: The contract specified that all AIG had to do, basically, was remain solvent. It didn't. And that's when the trouble started for transit agencies like Washington, D.C.'s, Metro.

The problem is that, when AIG went bust, its credit rating got downgraded. And that meant that Metro rail was technically in default on its sale-leaseback agreements. Under one of the contracts it had, that meant that Metrorail was liable for a penalty payment of $43 million.

CAROL KISSAL: When the entity was downgraded, actually, that's what triggered the technical default.

RICK KARR: So it doesn't mean that Metro couldn't make the payments. It just means that you were in violation of the fine print of the contract?

CAROL KISSAL: That's exactly right. I mean, Metro has always made their payment obligations. The lease payments are made. There has never been a default on a payment.

RICK KARR: But in October, the Belgian bank KBC gave the agency just seven days to cough up $43 million in penalty payments because it was in technical default. Metro officials say they think the bank's request might have something to do with the fact that, in the quarter before it asked for its money, it wrote off bad assets and took a loss of $900 million euros, or more than $1 billion.

GORDON LINTON, Washington Metropolitan Area Transit Authority: The bank said, "OK, we want a jumbo payment right now, even though you have not missed any payments, you are not in default, this is only a technicality that we can take advantage of at this point. And we're going to use this opportunity because we're having some financial problems ourselves. And we're going to go to whatever extent we can to get money from whatever source that we have an opportunity."

RICK KARR: KBC and Washington Metro wound up in court. A judge ordered the two sides to hash out an agreement, which they did. But even though public money is at stake, both sides are bound by a confidentiality agreement. Metro's Carol Kissal says that's something the banks demanded.

CAROL KISSAL: I think that we should have the ability to disclose -- as a public entity, you should reveal how those monies are being spent.

Bad advice from the government

RICK KARR: Meanwhile, the agency is still on the hook for 12 more sale-leaseback agreements worth around $300 million, while other agencies may have to cough up billions more.

Transit advocates say the federal government's to blame for the extent of the problem, because, starting in the 1990s, the Federal Transit Administration promoted innovative financing techniques, including sale-leaseback deals, as a way to help out underfunded transit systems.

Kissal says the Fed didn't do enough to warn transit agencies about the potential pitfalls of a risky financing scheme.

CAROL KISSAL: We run a train. And, you know, we need capital in order to put trains on the network. We relied on the federal government, who was positioning these types of transactions as a way to finance some of the urgent capital needs. And most of the transits, you know, signed up for it willingly, because it was deemed approved by the federal government.

RICK KARR: Even before AIG collapsed, the sale-leaseback deals had come under fire in Washington. Republican Senator Charles Grassley of Iowa says the FTA should have known that the deals were nothing more than tax dodges for banks.

SEN. CHARLES GRASSLEY, R-Iowa: Late in the Clinton administration, the IRS was advising the Federal Transit Authority not to do it. Well, should we have one federal agency saying you ought to get into a scheme to misuse the tax code, when the IRS is telling you, 'Shut those down; you shouldn't be making that advice, you know'?"

Cutting back on maintenance

RICK KARR: In 2004, Grassley and his Democratic colleague, Max Baucus of Montana, pushed through legislation that prohibited new sale-leaseback deals, but Washington Metro and 30 other transit agencies nationwide are still on the hook for old deals worth hundreds of millions of dollars.

Metro says, if they're forced to pay up, the first thing they're likely to cut is maintenance on escalators and elevators. That would be particularly bad news for riders like Cinda Hughes, who depend on transit the most.

CINDA HUGHES: Public transportation equals independence for a person with a disability.

RICK KARR: What impact do you think it would have if Metro had to cut back on maintenance of elevators?

CINDA HUGHES: It would be devastating. It would be devastating, because I would not be able to get back and forth to work. It would cost $35 for me to take one-way trip on a taxi. And so it would be cost-prohibitive for me to be able to work in town. And I would not be able to do my work if it weren't for the Metro system.

RICK KARR: Once the lease deals went bad, transit agencies banded together to ask Congress for some help. What they wanted was for the federal government to step in and ensure the deals in lieu of AIG.

Last November, the Senate took up a proposal to do that. Opponents argued that the plan would have rewarded the banks by legitimizing the tax shelters. A bipartisan majority agreed and voted it down.

Iowa Republican Charles Grassley says transit agencies will have to make good on their deals with the banks. And if that means they go broke, they can ask Congress for help later this year.

SEN. CHARLES GRASSLEY: If transit agencies have a problem, for whatever reason, this one or other reasons, there's an opportunity to deal with that. Every five years, we do a transportation bill. And this is a year to do a transportation. That's highways; that's mass transit. So they'll have a chance to come and present their case to us.

RICK KARR: But transit officials hope that they won't have to wait that long. They're trying to convince Treasury officials to help them get the banks off their backs right now.

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